A Well Diversified Portfolio Is A Nice Idea, But…

The first problem with a well diversified portfolio is the inherent assumption that asset classes are negatively correlated, meaning that if one asset within the portfolio were to fall, the loss would be offset by a rise in another asset. During a financial crisis however, almost all asset classes become positively correlated, meaning that they all move up or down together. This makes constructing a diversified portfolio virtually impossible.

The second problem is that in seeking a diversified portfolio, you are trying to cater for as many different outcomes as possible. Which is really just another way of saying I have no idea what’s going to happen, and if you have no idea what’s going to happen then you should probably keep your money in the bank and accept that you will lose money to inflation.

“Wide diversification is only required when investors do not understand what they are doing.” Warren Buffett

Anyone putting money to work in the financial markets ought to have some sort of view as to what the future might hold, even if their thesis is as basic as rising population or changing demographics.

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